Second Circuit Overturns District Court’s Rejection of SEC-Citigroup Fraud Settlement

In a closely-watched decision involving judicial review of agency settlements, the Unites States Court of Appeals for the Second Circuit vacated United States District Court Judge Jed Rakoff’s 2011 order rejecting a proposed $285 million settlement between the Securities and Exchange Commission (“SEC”) and Citigroup Global Markets Inc., finding that the judge applied an incorrect legal standard in his review of the proposed accord. S.E.C. v. Citigroup Global Mkts., Inc., No. 11-5227-CV L, 2014 WL 2486793 (2d Cir. June 4, 2014). The Second Circuit held that, under the proper standard, the district court is required to determine whether the consent decree is fair and reasonable, and, if it includes injunctive relief, whether the public interest “would not be disserved.” Absent a substantial basis in the record to the contrary, the appeals court held, the district court is required to enter the order.

In October of 2011, the SEC filed a complaint against Citigroup in the United States District Court for the Southern District of New York alleging that the bank misled investors about a billion-dollar collateralized debt obligation. Shortly thereafter, the SEC filed a proposed consent judgment wherein Citigroup agreed to, among other things, a permanent injunction barring it from future violations of the securities laws, disgorgement of $160 million, and a civil penalty of $95 million. The proposed consent decree did not include any admission of wrongdoing.

After conducting a hearing to explore the basis of the settlement, the district court issued a written opinion rejecting the proposed accord and set a trial date. See S.E.C. v. Citigroup Global Markets Inc., 827 F. Supp. 2d 328 (S.D.N.Y. 2011). The district court held that “before a court may employ its injunctive and contempt powers in support of an administrative settlement, it is required, even after giving substantial deference to the views of the administrative agency, to be satisfied that it is not being used as a tool to enforce an agreement that is unfair, unreasonable, inadequate, or in contravention of the public interest.”

In his ruling, he took particular exception with the absence of any admission or denial of liability by Citigroup. He compared the proposed consent decree unfavorably to the SEC’s 2010 settlements with Bank of America and Goldman Sachs. In those cases, the district judge observed, the parties had stipulated to certain findings of fact. Here, by contrast, “[w]ithout such an evidentiary basis in this case . . . the Court is forced to conclude that a proposed Consent Judgment that asks the Court to impose substantial injunctive relief, enforced by the Court’s own contempt power, on the basis of allegations unsupported by any proven or acknowledged facts whatsoever, is neither reasonable, nor fair, nor adequate, nor in the public interest.” Rejecting the proposed consent decree, the district court observed that an “application of judicial power that does not rest on facts is worse than mindless, it is inherently dangerous. The injunctive power of the judiciary is not a free-roving remedy to be invoked at the whim of a regulatory agency, even with the consent of the regulated. If its deployment does not rest on facts — cold, hard, solid facts, established either by admissions or by trials — it serves no lawful or moral purpose and is simply an engine of oppression.”

On appeal, the Second Circuit vacated the lower court’s order and remanded for further proceedings consistent with its opinion.

The Second Circuit ruled that the lower court exceeded its authority in reviewing the adequacy of the settlement, holding that district courts are limited to determining whether a proposed consent judgment is fair and reasonable, and, if it includes injunctive relief, whether the “public interest would not be disserved.” The Court held that district courts are required to enter the order absent a substantial basis in the record to the contrary.

Focusing on the district court’s insistence that the consent decree contain “proven or acknowledged facts,” the Second Circuit held that it was an abuse of discretion to require, as the district court did here, that the SEC establish the “truth” of its allegations as a condition for approving a consent decree. The Court held that the lower court failed to give “significant deference” to the SEC by presenting the parties with a questionnaire and comparing the proposed accord unfavorably to settlements in other matters.

The Second Circuit also held that the district court applied the wrong standard of review by defining the “public interest” as “an overriding interest in knowing the truth.” It held that it is an abuse of discretion for a district court to find the public interest disserved “based on its disagreement with the S.E.C.’s decisions on discretionary matters of policy, such as deciding to settle without requiring an admission of liability.”

A significant aspect of the Second Circuit’s decision is its clarification of the scope of deference district courts owe federal agencies seeking approval of consent decrees. The Court held that “the job of determining whether the proposed S.E.C. consent decree best serves the public interest, however, rests squarely with the S.E.C. and its decision merits significant deference.”

Before the Second Circuit’s decision in Citigroup, the SEC was forced to operate under the uncertainty of whether other district courts would follow Judge Rakoff’s approach and insist that its settlements contain admissions of wrongdoing or at least some sort of factual predicate for the settlement. In effect, the Second Circuit’s ruling vindicates the SEC’s use of “no-admit, no-deny” settlements, an integral part of its enforcement regime, and frees the SEC to settle cases through consent decrees without the burden of justifying its settlement. Without this burden, the SEC will be able to resolve cases more quickly and, therefore, more efficiently manage its enforcement docket.

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